Chapter 11, Problem 1CYU

a)

To determine

The question requires us to determine the nominal GDP and real GDP.

Explanation of Solution

Real GDP is the value of GDP calculated at the base year prices. It is the inflation-adjusted value of all final goods and services in a given year in an economy.

The nominal GDP is calculated by using the current year's prices as it doesn’t adjust for inflation.

From the table:

1. The cost of a basket in year 1:

  $\begin{array}{l}={\displaystyle \sum \left(\text{Current year quantities }\times \text{ Current year prices}\right)}\\ =\left(\$0.40\times 1000000\right)+\left(\$0.60\times 800000\right)\\ =\$400000+\$480000\\ =\$880000\end{array}$

The value of nominal GDP in year 1 is $880000.

2. The cost of a basket in year 1:

  $\begin{array}{l}={\displaystyle \sum \left(\text{Current year quantities }\times \text{ Current year prices}\right)}\\ =\left(\$0.50\times 900000\right)+\left(\$0.51\times 840000\right)\\ =\$450000+\$428400\\ =\$878400\end{array}$

The value of nominal GDP in year 2 is $878400.

3. The cost of a basket in year 1:

  $\begin{array}{l}={\displaystyle \sum \left(\text{Current year quantities }\times \text{ Base year prices}\right)}\\ =\left(\$0.40\times 900000\right)+\left(\$0.60\times 840000\right)\\ =\$360000+\$504000\\ =\$864000\end{array}$

The value of real GDP in year 2 when the base year is year 1 = $880000.

b)

To determine

The question requires us to determine the reason for the misguided result when the assessment of growth uses the nominal GDP.

Explanation of Solution

The growth assessment using the value of nominal GDP in a country is misguided because nominal GDP is calculated by using the current year's prices as it doesn’t adjust for inflation. So, it doesn’t give real growth data.

For example, suppose the GDP growth rate (using nominal GDP) is 4% per annum while the rate of inflation in the economy is 3% per annum. Here, the real growth would be 1%, but using the nominal value gives the exaggerated value of the growth.